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Going for growth

IF your business growth model stands the test strategically then three critical questions arise – determining optimal capital structure, the sources of growth capital, and what to expect once you have re-capitalised for growth.

The question of optimal capital structure sounds technical, but it’s not, even though large companies necessarily spend significant amounts of time on precisely this issue.

Anyone with an asset or any form of investments is making capital struct-uring decisions on a daily basis. So keep it simple and consider capital along a spectrum.

At the low risk and low-priced end you have debt – cheapest, but secured most likely against your assets, and not necessarily just your business assets. So if you are going for growth using debt you are leveraging or gearing your growth, this requires healthy and stable cash flows and quality collateral to secure the debt. If you cannot or don’t want to use this form of capital, then the next general category is mezzanine finance.

In the middle, mezzanine capital typically takes the form of convertible notes, higher priced debt with equity option attachments or shareholder loans. This form of capital is more expensive, but possibly available in the absence of a stable cash flow history and asset backing.

At the high priced end is equity. Provided by shareholders, equity – despite many misconceptions – is the most expensive form of capital. Look forward to giving up a share of the profitability of the business now and into the future. If you lack stable existing cash flows, any form of historical earnings and lack asset backing for collateral, you will have few alternatives.

So, where do you source the capital and what should you expect?

Debt is available through trading banks and you will be wise to utilise an existing relationship where your banker can assist with the articulation of your growth plan.

Don’t be afraid to speak to alternative banks, as their criteria for lending into different industry segments will always vary over time. Bank finance is terrific but be prepared to closely service your facilities and don’t get too adventurous in the current environment.

Mezzanine is the domain of the investment banks and private equity providers, along with possibly a number of professional investors. Expect a rigorous examination of the possible downside of your business model and be very sure that you can cover interest payments often twice to three times the bank rate. If you don’t like the sound of that sort of capital, don’t ask for it.

Equity, of course, is well known. If you have a great story and can sell it, in times past you might race to the public markets with an IPO. Don’t be naive, IPOs are few and far between currently and, in the absence of a multi-million dollar EBIT line and three years’ historicals, your best source of equity is likely to be a known business partner, private equity funds, corporate players in related industry segments or known professional investors.

Be prepared to dilute, to work very hard for a few more years, realising the full value or your growth model, and to subject yourself to detailed scrutiny of your business performance.

Most businesses finance their growth using some combination of these sources. No matter what the structure you pursue remember, going for growth will change your life. If you expect to be uncomfortable, challenged, frightened, distracted and frustrated – usually all in the one day – you will have prepared yourself for the true cost of capital.

The writer can be contacted at anthony.wooles@trudo.com.au or through the office at BusinessNews.

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